Cyprus: Economy Dynamics 2Q2014 September 2014 At a Glance Contents At a Glance 1 Macroeconomics Forecasts 2 The Cyprus Macroeconomic Adjustment Program (CMAP) 3 Major Challenges Persist 4 Public Finance Developments 5 Unemployment Remains the Major Challenge 6 On a Path to Recovery 7 Abbreviations 9 References 9 In 2Q2014, the Cypriot economy contracted by 2.5% in constant prices while unemployment continued to remain in high levels at 15.3% in 2Q2014. The gross public debt reached 111.7% of GDP at YE2013, up by 25.1% YoY (Year on Year). In 2Q2014, the fiscal deficit was 7.0mn (-0.04% of GDP), with the total revenue and grants ( 3,046mn) outstripping the government expenses and net lending ( 3,039mn). Moreover, 2Q2014 recorded a deflation equal to -2.0% compared with 2Q2013. While unemployment remains the biggest challenge faced by the Cypriot economy, the unemployment rate in Cyprus dropped by 0.6% QoQ (Quarter on Quarter) to 15.1% in 2Q2014 perhaps showing signs of plateauing. The Cypriot economy continues to contract and faces significant headwinds in 2014, both fiscally and in key sectors of the economy, such as banking and real estate development. Its overall performance however, is above the expectations of the Troika (European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF)) as included in the revised Memorandum of Understanding on Specific Economic Policy Conditionality for Cyprus (MoU, August, 2014). In fact, the latest reports from the Troika are positive, with forecasts for the macroeconomic outlook for Cyprus revised upwards (EC Forecast, Spring, 2014). Dominion Bond Rating Service (DBRS) (2014) upgraded the long-term foreign currency issuer ratings for Cyprus from CCC to B. Fitch (2014) revised its fiscal projections to a deficit of 5% of GDP in 2014 and 4.6% in 2015, down from its previous forecasts of 7.5% and 6.9% respectively. Table 1: Macroeconomic Indicators (%) 2011 2012 2013 1Q2014 2Q2014 GDP (growth rate) 0.4-2.4-5.4-3.9-2.5 Unemployment rate 7.9 11.9 15.9 15.7 15.1 Inflation rate * 3.3 2.4-0.4-2.6-2.0 Primary balance (% of GDP) -3.9-3.1-0.6 0.7 1.1 Gross public debt (% of GDP) 71.5 86.6 111.7 112.2 N/A Current account balance (% of GDP) -3.4-6.9-1.9-15.9 N/A Final consumption expenditure (% of GDP) 87.8 88 88 88.3 84.7 *According to the Consumer Price Index Sources: CyStat (2014), Eurostat (2014), MoF (2014)
Macroeconomic Forecasts After the positive assessment of the 4th quarterly review of Cyprus s macroeconomic adjustment programme, the European Stability Mechanism (ESM), approved the disbursement of 600mn to Cyprus on July 7, 2014, bringing the total amount of ESM assistance to 5.35bn as at July 9, 2014.The remaining amount that the ESM initially committed to Cyprus (c. 9bn) will be paid in quarterly instalments until 2016, as scheduled (ESM, 2014). Also, 84mn of the 1bn 3-year loan approved by IMF to Cyprus (May 2013), has already been disbursed (July 2, 2014) after the completion of the 4th quarterly review. The final Eurogroup decision for the payment of the next tranche, comprising 350mn by the ESM and about 86mn by the IMF, was not part of the agenda of the scheduled Eurogroup meeting in September as originally expected. The delay was the result of the Government s failure to satisfy the requirement for the passing of foreclosure legislation that will shorten the amount of time required for lenders to repossess property collateral. The GDP is expected to shrink by 4.0% in 2014 and minor growth of 0.5-1.0% is expected for 2015 (EC, 2014). In contrast, Fitch (2014) expect growth to resume in 2017 and not in 2015. The IMF expects that the economy could start growing immediately, despite the scarcity of bank lending, with financing expected to flow from businesses in sectors that were not severely affected by the recession and were not over-leveraged. The IMF highlights the tourism and other services sectors such as health, energy and education, which could support the Cypriot economy within the next two years. Confidence in the economy shows signs of improvement. According to the economic sentiment indicator published by the Economics Research Centre of the University of Cyprus (CypERC) confidence in the economy has improved by 0.6 points in June 2014 compared to May 2014. The increase, which is the 14th consecutive monthly increase recorded since April 2013, is attributed mainly to a strengthening of the economic confidence of the consumers and due to a marginal improvement in the business climate in the construction. According to the 5th Troika review in July 2014, there are signs of stabilisation in the Cypriot banking system. However, the economic outlook overall remains negative. Implementation of the MoU agreed with the Troika last year remains on track. Fiscal targets for 1H2014 were comfortably met, however additional effort is needed to achieve the target of a primary surplus of 4% of GDP by 2018 (1Q2014: 0.7%). Table 2: Macroeconomic Forecasts (%) EC Ministry of Finance (MoF) 2014 2015 2016 2014 2015 2016 GDP growth -4.8 0.9 N/A -4.8 0.9 1.9 HICP 0.4 1.4 N/A N/A N/A N/A Unemployment Rate 19.2 18.4 N/A 19.2 18.4 17.0 Current Account Balance (% GDP) 0 0.4 N/A 0.1 0.1 1.4 Gross Public Debt (% GDP) 122.2 126.4 N/A 120.4 118.0 111.0 General Government Balance (% GDP) -5.8-6.1 N/A -5.8-6.0-2.8 Sources: EC (Forecast Spring, 2014), MoF (2014) 1 The disbursements are shown in Table 3. 2 The economic sentiment indicator compiled on a monthly basis by the Economics Research Centre of the University of Cyprus reports consists of weighted answers regarding the current status of all sectors and consumers. The sectors that are included in the indicator are services, retail trade, construction, industry and consumers. The weights used in the calculation of the Economic Sentiment Indicator reflect the contribution of each sector to the GDP of Cyprus. 2 Cyprus: economy dynamics August 2014
The Cyprus Macroeconomic Adjustment Program (CMAP) March 2013 Approval by the Cyprus Parliament of the bail-in of depositors at troubled Cypriot Banks. April 2013 Approval of CMAP by the Euro Area Member States. April 2013 Introduction of Immovable Property Tax (IPT) for all property owners. May 2013 Approval of CMAP by the IMF. July 2013 Implementation of changes to the Financial Ombudsman Law of 2010. September 2013 March 2014 CBC issues a Directive on arrears management and a Code of Conduct for dealing with troubled borrowers. Approval of the Privatisation Law by the Cyprus Parliament. May 2014 July 2014 The Ministry of Health and the Troika agreed in principle on a roadmap of implementation of the National Health System (NHS). Introduction of a Minimum Guaranteed Income (MGI), of 480/month. September 2014 Approval of the foreclosures legislation and a series of related laws by the Cyprus Parliament. Table 3: Disbursements of ESM IMF Financial Assistance to Cyprus Tranche Creditor Nominal Amount ( mn) 1st 2nd 3rd 4th 5th 6th Source: MoF (2014) Disbursement Date Cumulative Amount ( mn) ESM 2,000 13/05/2013 2,000 IMF 86 17/05/2013 2,086 ESM 1,000 26/06/2013 3,086 IMF 83.7 18/09/2013 3,170 ESM 1,500 27/09/2013 4,669 ESM 100 19/12/2013 4,769 IMF 83.5 24/12/2013 4,853 ESM 150 04/04/2014 5,003 IMF 83.3 02/04/2014 5,086 ESM 600 09/07/2014 5,686 IMF 84 02/07/2014 5,770 ESM 350 Fall 2014 6,120 IMF 86 Fall 2014 6,206 3 Cyprus: economy dynamics August 2014
Major Challenges Persist One of the biggest challenges for the Cypriot economy is the required decrease in public debt, which reached 112.2% of GDP in 1Q2014. The MoF (Ministry of Finance) forecasts that public debt will reach 120.4% in 2014. Several measures agreed under the MoU (April 2013), including scaled public sector wage cuts, rationalisation of social benefits and pensions, increases in VAT and excise taxes, as well as increased social security contributions, are all aimed at reducing the public debt to sustainable levels. The implementation of the measures prescribed by the MoU has so far been successful and the results achieved have been positive. Nevertheless, the measures aimed at public debt reduction have had a negative impact on the overall economic activity and direct (and indirect) social consequences, such as the reduction of social benefits, increased unemployment, etc. As part of the MoU, the Cyprus government is expected to introduce measures aimed at protecting the vulnerable social groups, including the low-income families, the unemployed, and the disabled. In July 10, 2014 a Law was passed by the House of Representatives with regard to the minimum guaranteed income (MGI) policy, which will provide state benefits (housing and/ or income subsidies) to everybody below the MGI threshold. The policy is expected to help rationalise the state-sponsored benefits and allowances system, allowing for more efficient and cost-effective administration. The government began accepting applications for the welfare package in July 18, 2014. Legislation that paves the way for the privatisation of the three largest state-owned enterprises was passed last March and the process is proceeding as planned in the MoU. On April 30, 2014, a privatisations officer was appointed by the Council of Ministers. The Troika expects that the privatisations will generate about 1bn by the end of the programme period (2016) and an additional amount of 400mn until 2018, which will be used for public debt reduction (MoU, May 2014). Figure 1: Public Debt of Cyprus as a percentage of GDP 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Public Debt (%of GDP) Forecasts by MoF Source: MoF (2014) 4 Cyprus: economy dynamics August 2014
Public Finance Developments The general government deficit for 2013 ( 896.9mn, 5.4% of GDP) was lower than in 2012 ( 1134.9mn, 6.4% of GDP). In 1Q2014, the general government deficit was 31.6mn or -0.8% of GDP, decreased by 556.7mn compared to 4Q2013.The EC forecasts a further increase in the General Government Deficit in both 2014 and 2015. In a more recent report, Fitch (2014) revised its initial projections and it now expects the General Government Deficit to improve to 5% of GDP in 2014 and to 4.6% in 2015. The decrease in the General Government Deficit resulted mainly through the decrease in government expenditure (mainly attributed to reductions in payroll expenses as well as social security payments). The total reduction in payroll expenses in 2013 amounted to 132mn compared to those incurred in 2012, while there was an annual increase in social security payments of about 71mn in 2013. The current revenue and expenditure for the months January to June 2014 are presented in Table 4. Figure 2: General Government Deficit as a percentage of GDP 3.5% 2006 2007 0.9% 2008 2009 2010 2011 2012 2013 2014 2015 2016-1.2% -2.8% -6.1% -5.3% -6.3% -6.4% -5.4% -5.8% -6% Source: MoF (2014) Actual data Forecasts by MoF Table 4: Current Account ( mn) January June 2014 January- June 2013 % Change 1. Revenue and Grants 3,046 2,983 2% Current Revenue 3,017 2,964 2% Tax Revenue 2,492 2,419 3% Direct taxes 906 851 7% Indirect Taxes 1,116 1,114 0% Social Security Contributions 470 454 4% Non Tax Revenue 525 545-4% 2. Expenditure and Net Lending 3,039 3,254-7% Wages and Salaries 798 835-5% Interest Payments 218 307-29% Social Security Payments 754 716 5% Pension and Gratuities 281 298-6% Social Pension 31 30 2% Overall balance ( 1 2) 7-271 Overall Balance as % of GDP 0.04% -1.6% Source: MoF (2014) 5 Cyprus: economy dynamics August 2014
Unemployment Remains The Major Challenge According to data published by European Statistical Service (Eurostat) in June 2014, unemployment stood at 15.0% (May 2014: 15.1%), with youth unemployment (less than 25 years) at 35.1%, among the highest rates in the EU-28. As shown in Figure 3, unemployment has been increasing since 2009. Between 2011 and 2013 Cyprus recorded the highest increase in unemployment rate amongst the EU-28 member states. The government introduced several new programs to encourage the hiring and/or retraining of the unemployed. For example, a six-month placement program for unemployed graduates in order to gain work experience was introduced in March 2014, aimed at creating 2,500 new jobs for unemployed graduates up to 35 years old. According to data published by Cyprus Statistical Service (CyStat), in July 2014, the registered unemployed persons increased to 46,727 (June 2014: 44,925), a monthly increase of 4%. The main sectors contributing to the rise in unemployment over the last few years are the wholesale and retail trade sector, the hospitality sector and the construction sector. For the first seven months of the year, the number of registered unemployed persons reached 48,705 of which 17.8% (8,653 persons) were from the wholesale and retail trade sector,14% (6,815 persons) from the constuction sector and 13.2% (6,431 persons) from the hospitality sector. Figure 3: Unemployment Rate of Cyprus and EU-28 (%) 2006 2007 2008 2009 4.6% 3.9% 3.7% 5.4% 8.2% 7.2% 7.0% 9.0% 2010 6.3% 9.6% 2011 2012 7.9% 9.6% 11.9% 10.4% 2013 10.8% 15.9% 2014 2015 2016 17% 19.2% 18.4% Unemployment Rate Cy Forecasts by MoF for CY Unemployment Rate EU-28 Source: Eurostat (2014) 6 Cyprus: economy dynamics August 2014
On A Path To Recovery Increased Government Income In June 2014, the total income tax receipts increased marginally by 0.2% or 1.4mn YoY. Specifically, the total amount paid to the Inland Revenue Department (IRD) for the 2Q2014 was 728.6mn, compared to 727.2mn in 2Q2013. The marginal increase is mainly attributed to the imposed penalties and the capital gains tax. Increased Imports and Exports In June 2014, the total imports increased by 5.1% YOY ( 422.1mn compared to 401.8mn in June 2013). In addition, the total exports recorded an increase of 8.4%, reaching 146.4mn in June 2014 up from 135.1mn in June 2013. The trade balance deficit increased by 7.6% to 1602.5mn in the first half of 2014, up from 1488.6mn in the first half of 2013. SMEs In April 2014, the European Investment Bank (EIB) agreed to provide a 50mn credit line for Cypriot SMEs. The financing will be disbursed through the Cooperative Central Bank (CCB), which will also provide further SME financing of their own. In 2013, the EIB support for Cyprus reached 250mn, of which 60% went to SMEs ( 150mn), 37% ( 92.5mn) to infrastructure projects and 3% ( 7.5mn) to industry. initiative could receive funds from German and EU financing organisations (EIB, European Reconstruction and Development Bank (ERDB)). Although the details of the amount and the process of the financing have yet to be finalised, the initiative is expected to provide a welcome source of financing for the Cypriot SMEs and contribute to job creation. Increase in Applications for Registration of Companies In July 2014, the applications for registration of companies in Cyprus recorded the highest increase since March 2013. The increase is partly attributed to the positive 4th quartery review by the Troika in June. According to data from the Registrar of Companies and Official receiver, there were 1,138 applications for registration of new companies in July 2014, (up from 908 in July 2013, a 25.3% increase). The total new registrations for the first seven months of 2014 were 5,254 (suggesting that the new company registrations for FY2014 could be at similar levels as those in 2013). Additionally, the Government announced that it is preparing a private financing corporation that will provide financing for SMEs. According to the government, the Table 5: New Company Registrations 2009 2010 2011 2012 2013 Jan-July 2014 16,101 19,278 19,538 17,999 10,847 6,138 Source: Department of Registrar of Companies and Official Receiver (2014) 7 Cyprus: economy dynamics August 2014
On A Path To Recovery Lifting of Capital Control Measures Following the achievement of the set milestones, the MoF announced on May 30, 2014 that all restrictions on transactions within Cyprus would be abolished. The cashing of cheques is now permitted and the limits on transfers and payments of 50,000 for individuals and 200,000 for legal persons per institution have been abolished. The restrictions in the opening of new accounts at credit institutions and for capital flows out of Cyprus remain in place. The gradual abolition of restrictive measures is expected to help increase liquidity in the market and boost the overall economic activity. of the Cypriot MoU, with regards to both the fiscal targets and the structural reforms. Importantly, the decrease in CGB yields suggests that Cyprus could start borrowing from the international markets sooner than had been expected. Already, Moody s (2014) upgraded the prospects for the CGB from negative to positive, retaining their rating at Caa3. However, the rating is still negative due to the risk of default or debt restructuring in the short run that persists as the public finances remain highly correlated to the banking sector. Better Performance of Cypriot Government Bonds The yields of the Cypriot Government Bonds (CGBs), reached their lowest levels since May 2011, when the steep rise in yields had forced the Cyprus government out of the international bond markets. The performance in the yields is attributed to the improvement of the Eurozone economy and also to the successful implementation Figure 4: Cyprus Government Bond Yields 25 20 15 10 5 0 Jun 12 Sept 12 Dec 12 Mar 13 Jun 13 Sept 13 Dec 13 Mar 14 Jun 14 CGB 15 Y CGB 20 Y Source: Bloomberg (2014) 8 Cyprus: economy dynamics August 2014
Abbreviations CBC Central Bank of Cyprus CCB Cooperative Central Bank CGB Cypriot Government Bond CSE Cyprus Stock Exchange CypERC Economics Research Centre of the University of Cyprus CyStat Cyprus Statistical Service GDP Growth Domestic Product CMAP Cyprus Macroeconomic Adjustment Program DBRS Dominion Bond Rating System EC European Commission ECB European Central Bank EIB European Investment Bank ERDB European Reconstruction and Development Bank ESM European Stability Mechanism Eurostat European Statistical Service GDP Gross Domestic Product IMF International Monetary Fund IRD Inland Revenue Department References CYPRUS. Central Bank of Cyprus (2013) ECONOMIC BULLETIN DECEMBER 2013. Economics Research Centre of University of Cyprus (2014) Business and Consumer Surveys, April 2014. CYPRUS. Ministry of Finance (2014) Cyprus: Public Finances. CYPRUS. Ministry of Finance. (2013) Economic Developments in 2013 and Prospects for 2014. EUROPEAN COMMISSION. (2014) Employment and Social Developments in Europe 2013. International Monetary Fund. (2014) Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding. IMF (2014). WORLD ECONOMIC OUTLOOK APRIL 2014. IMF (2014). Cyprus: Third Review under the Extended Arrangement under the Extended Fund Facility and Request for Modification of Performance Criteria-Staff Report; Press Release and Statement by the Executive Director. Country Report No. 14/92. MOODY S (2014) Global Credit Research. The World Bank (2013) Latvia: Who is Unemployed, Inactive or Needy? Assessing Post-Crisis Policy Options. Latvia GMI program: Main design Characteristics and Comparison with Minimum Income Schemes in Other EU Member States. MGI Minimum Guaranteed Income MoF Ministry of Finance MoU Memorandum of Understanding on Specific Economic Policy Conditionality QoQ Quarter on Quarter SMEs Small and Medium Enterprises S&P Standard and Poor s Troika European Commission, European Central Bank, International Monetary Fund VAT Value Added Tax YoY Year on Year 9 Cyprus: economy dynamics August 2014
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